Qantas-British Airways merger has the ingredients for success

BA was a cornerstone 25% investor in the 1995 float of Qantas (adding significant value to the Australian airline's subsequent IPO), but BA sold its (reduced) stake in Qantas in Sep-04. More than a decade on, Qantas appears to be returning the favour, with BA shares leaping 12.5% yesterday on the news (its biggest daily increase since 2002), while Qantas shares have added approximately 5% in Sydney today (midday).

The potential Qantas deal adds to BA's complex web of other merger negotiations involving Iberia and American Airlines. Any or all of these deals are massive undertakings and are a direct response to the toxic environment airlines face with rising costs and falling revenues, but also the unprecedented opportunity to create a global carrier as ownership and control and access restrictions ease around the world. In this regard, BA is also moving to counter the threat posed by the expanding influence of the acquisitive Lufthansa and Air France-KLM groups.

British Airways - The World's (Shrinking) Airline

BA and Qantas also have to contend with fast-growing entrants, likes of Emirates, which has catapulted into fifth place on the list of the world's largest international airlines (by RPKs, as at 2007). British Airways is actually 2% smaller than it was in 1997, while Qantas has left the Global Top 10 altogether.

Then and Now: Global Top 10 airlines by traffic (RPKs): 1998 vs 2007

International	1998		2007
Rank	Airline	Millions	Airline	Millions
1	British Airways	112,365	Air France	118,112
2	United Airlines	75,170	Lufthansa	116,838
3	Lufthansa	70,051	British Airways	110,320
4	Air France	65,955	Singapore Airlines	90,901
5	Japan Airlines	62,018	Emirates	90,530
6	American Airlines	58,288	American Airlines	81,324
7	Singapore Airlines	57,737	United Airlines	77,709
8	KLM	57,271	Cathay Pacific	74,987
9	Northwest Airlines	48,319	KLM	74,488
10	Qantas	42,731	Delta Air Lines	63,202
Domestic	1998		2007
Rank	Airline	Millions	Airline	Millions
1	Delta Air Lines	126,266	American Airlines	141,437
2	United Airlines	125,251	Southwest Airlines	116,385
3	American Airlines	116,961	United Airlines	114,224
4	Northwest Airlines	59,083	Delta Air Lines	103,008
5	US Airways	59,058	Continental Airlines	74,126
6	Continental Airlines	57,049	China Southern Airlines	69,367
7	All Nippon Airways	33,732	Northwest Airlines	63,872
8	TWA	31,819	US Airways	52,018
9	America West Airlines	25,512	JetBlue	41,395
10	Japan Airlines	16,796	All Nippon Airways	39,098
Total	1998		2007
Rank	Airline	Millions	Airline	Millions
1	United Airlines	200,421	American Airlines	222,761
2	American Airlines	175,249	United Airlines	191,933
3	Delta Air Lines	166,154	Delta Air Lines	166,209
4	British Airways	116,001	Continental Airlines	130,965
5	Northwest Airlines	107,402	Air France	128,914
6	Continental Airlines	79,778	Lufthansa	122,091
7	Japan Airlines	78,813	Northwest Airlines	117,357
8	Lufthansa	75,438	Southwest Airlines	116,385
9	Air France	74,598	British Airways	113,275
10	US Airways	66,389	Singapore Arlines Ltd	90,901

Source: Centre for Asia Pacific Aviation & IATA WATS

British Airways' international network is over four times bigger than Qantas' (in terms of seats per week), although a big proportion of BA's international capacity (71%) is short-haul European capacity. Stripping this out, BA is just 25% larger than Qantas in terms of its international network size.

British Airways vs Qantas international network by region (seats per week): Dec-08

Source: Centre for Asia Pacific Aviation & OAG.

BA has roughly twice as many jet aircraft in its fleet than Qantas (though a much larger proportion of narrowbodies). Qantas however has considerably more aircraft on order than BA (106 vs 60), and much more attractive early positions in the crucial B787 and A380 production lines.

Qantas jet fleet and orders: At Dec-08

	Aircraft Type	In Service	Order	Grand Total
Airbus	A330	15	1	16
	A380	1	19	20
Boeing	747	32		32
	767	28		28
	787		55	55
	737 (CFMI)	18		18
	737 (NG)	38	31	69
Grand Total		132	106	238

Source: Centre for Asia Pacific Aviation & Ascend

British Airways jet fleet and orders: At Dec-08

	Aircraft Type	In Service	Order	Grand Total
Airbus	A318		2	2
	A319	33		33
	A320	32	12	44
	A321	11		11
	A380		12	12
Boeing	747	54		54
	757	11		11
	767	21		21
	777	42	10	52
	787		24	24
	737 (CFMI)	28		28
Grand Total		232	60	292

Source: Centre for Asia Pacific Aviation & Ascend.

Synergies

Both carriers are well into multi-year restructuring and cost cutting programmes. The next step up in cost savings could come from a merger, targeting further cost savings through joint operations, crewing and ground services. Most of the duplication of resources has been removed thanks to the BA-QF Joint Services Agreement, but there are some key revenue synergies through greater network linkages and feeds in their respective markets (European, trans-Atlantic and Asia Pacific) that could be secured.

Fleet

Qantas enjoys some excellent early positions on both the A380 and B787 production lines. A single BA-QF balance sheet could signal joint fleet operations more broadly across their networks. In an uncertain environment, particularly on the international front, added flexibility in the deployment of aircraft would be much sought after by both carriers.

Regulatory path

The two airlines have effectively been operating as one for the past decade on the Kangaroo route, so changes for the regional market from a merger will not be noticeable. The JSA has been subject to ACCC approval and is up for renewal mid next year. Australia's foreign airline ownership restrictions could be eased to up to 49% over the next 12 months (as the government's Aviation White Paper policy statement is finalised).

Jetstar

The BA-QF merger would bring together two premium-focused airlines, while Qantas also brings Jetstar to the table. The successful LCC is an interesting equation and is likely to be a vehicle that is used increasingly in servicing routes from Australia to Europe. There could potentially be a future role for Jetstar within Europe, but it is questionable whether the EU will permit a Jetstar model to operate as a European carrier, if it is not 51% owned by European nationals. But Australia is negotiating with the EU on a comprehensive aviation agreement. BA and Qantas will no doubt be lobbying for a precedent on the ownership question to be created.

CEO alignment

Crucial to the success of any deal will be the personal relationship between the respective airline CEOs. In the case of the Qantas-BA deal, the Irish connection between British Airways CEO Willie Walsh (a former Aer Lingus CEO) and new Qantas CEO Alan Joyce (who also spent eight years at Aer Lingus) is highly important. In light of the BA merger talks, the Qantas board's appointment of Mr Joyce takes on fresh significance. The personal affinity between the leaders could be the 'X factor' in a deal that will likely face considerable hurdles.